There is no doubt the telecommunications sector has been one of the best performing sectors over the past few years. Telstra Corporation Ltd (ASX: TLS) is the dominant player in the sector and has proven to be a great investment for shareholders over the past five years. According to Morningstar, Telstra has achieved an average total shareholder return (dividends + capital gains) of 24.7% each year over the past five years.
More recently however, the share price has fallen just under 10% since reaching a 52-week high of $6.74 in early February. The recent pull-back may be a buying opportunity, but let's look at some of Telstra's features:
For:
- Telstra offers a solid 4.9% dividend yield at current prices and this should provide support for the share price in the short term.
- The shares are fully franked
- Telstra is the clear leader in its sector and has a strong, trusted and recognisable brand.
- It is positioning itself to cater for the growing wireless and cloud markets which should generate future earnings growth.
- Telstra has the largest mobile network in Australia and offers the best quality coverage which provides a competitive advantage over other providers.
- The company is expanding into Asia which could provide earnings growth in the medium-term.
- Telstra has a strong balance sheet with strong cash flows.
Against:
- Shares are trading on a price-to-earnings ratio of around 18 which is not cheap compared to the rest of the market. If management are unable to deliver enough earnings growth to justify this premium, shareholders may be at risk of a substantial sell off.
- Telstra has a very high dividend payout ratio so significant earnings growth will be required to increase dividends over the long term.
- The desire for yield amongst investors has seen Telstra become one of the preferred income investments over the last few years. Once interest rates begin to rise, the investment case for Telstra becomes less attractive and could see investors move towards growth stocks.
- The mobile market is becoming more competitive and Telstra will need to continually invest in its network in order to maintain its competitive advantage.
- Delays with the NBN rollout creates uncertainty for Telstra in terms of cash compensation and that can impact on expected cash flows and dividends.
Although Telstra shares have become more attractively priced recently, I think investors have better opportunities elsewhere for market-beating returns. The current valuation suggests investors are expecting strong growth in earnings and dividends which I feel may be too optimistic. I believe holders of Telstra shares should continue to hold on to their shares but I would wait for further price falls before buying more shares.
